Sizing Up the Small-Business Jobs Machine

Praise of small businesses as the engine of the American economy is as much a part of political campaigns as bus tours, small-town diners and recycled stump speeches.

This week, no fewer than five of the eight Republican presidential candidates participating in a debate in Hanover, N.H., spent time talking about the importance of small businesses. No wonder, given that politicians through the years have credited small businesses with creating anywhere from 60% to 80% of new jobs.

So, do small businesses deserve their job-generating reputation? In short, yes.

Armed with new tools for tracking job creation, the Small Business Administration estimates such firms create about 65% of the nation’s net new jobs—jobs created minus jobs eliminated. And economists generally agree the figure is sound given the SBA’s criteria. There are big caveats, though, ranging from how small business is defined to how much the jobs pay and how long they last.

The first question: How small is small? The SBA’s Office of Advocacy, which produces the statistics, counts small businesses as those with fewer than 500 employees, which covers far more than garage tech start-ups and mom-and-pop stores. By that definition, 99.6% of the nation’s 4.8 million private employers that have been monitored for job creation by the Bureau of Labor Statistics for nearly a decade are small businesses.

“What they call a small business is not what anyone else calls a small business,” says David Neumark, director of the Center for Economics and Public Policy at the University of California, Irvine.

Joseph M. Johnson, chief economist of the SBA’s Office of Advocacy, disagrees. “SBA began using 500 employees as an overall definition for small business because it was the most common size standard,” he says.

One company that straddles the line between small and large is PROS Holdings Inc. in Houston. It is included in the SBA small-business stats with about 480 employees, and was founded by a husband-and-wife team in 1985. But the pricing-software maker looks like a large business today, as it has been traded on the New York Stock Exchange since 2007 and has a market capitalization of more than $400 million.

Those factors “make you scratch your head and say, ‘Does that sound like a mom-and-pop shop?’ ” says Tim Girgenti, chief marketing officer of PROS. However, he says the company exhibits some characteristics of a small business, such as a board that still includes its founders.

The European Union defines small- and medium-size enterprises as those with fewer than 250 employees. Small businesses, a subcategory, have fewer than 50 employees, according to European Commission spokesman Andrea Maresi. Define small businesses that way, and they created 32% of net new U.S. jobs since September 1992, when collection of such data began.

Beneath the 65% figure cited by the SBA is a lot more job creation and destruction than is immediately evident. Businesses with fewer than 500 employees accounted for about three of four jobs created since 1992, according to a paper from the Federal Reserve Bank of St. Louis published in April.

But many don’t last long. For instance, employers with fewer than four workers have accounted for roughly 5% of all private-sector workers since 1992, but 15% of all job creation and 15% of job destruction in the private sector in that period, according to BLS.

Such churning of jobs is hailed by economists as creative destruction, allocating resources to those sectors of the economy that can best use them. To workers, it is destructive to wealth accumulation and career advancement.

Small-business jobs also pay less. Last year, average weekly wages for employees at establishments with fewer than 100 employees ranged from $679 at shops with five to nine employees, to $815 at those with 50 to 99 employees, according to the Bureau of Labor Statistics. Average weekly wages topped $1,000 in all categories with at least 250 employees.

William Dunkelberg, chief economist of the National Federation of Independent Business, an industry association, said it doesn’t make sense to compare the wage averages.

“Not all of the people who are working at nail salons and barber shops could work for Eli Lilly & Co., but we all want them to have a job,” Dr. Dunkelberg says. “In fact, we all need them to have a job.”

A recent study called into question whether size should matter at all when comparing businesses and their contribution to job creation.

The paper—co-authored by University of Maryland economist John Haltiwanger and two Census Bureau economists—confirmed that small businesses create more net new jobs, per employee, than do bigger businesses.

But the effect vanishes once each company’s age is taken into account. It is young businesses that outperform old ones, according to the paper. Size isn’t the important factor.

If you control for age, “you wipe out that effect” of small businesses creating a disproportionate share of net new jobs, says Prof. Haltiwanger. “There’s no systematic relationship. If anything it goes the opposite way of conventional wisdom.”